Washington Limited Liability Companies
The Washington Limited Liability Company Act, RCW 25.15, governs the formation, operation and dissolution of limited liability companies (“LLCs”) in Washington.
Combining certain characteristics of both partnerships and corporations, LLCs are privately owned legal entities that can be formed for the purpose of earning profits, pursuing a social mission, or both, although some states require an LLC to be formed only for a “business purpose.” LLCs differ from for-profit corporations because they are formed and owned by members rather than shareholders; however, like S corporations and partnerships, LLCs are eligible for pass-through income tax treatment. This means that income and expenses are reported as though the members incurred them directly, and profits or losses are taxed at the ownership (member) level, rather than the entity (company) level.
Members of LLCs can be individual investors as well as for-profit corporations and tax-exempt nonprofit corporations. For this reason and also because of pass-through taxation which eliminates “double taxation” (the effect of taxing income at the corporate level and again when it is included in the owner’s income), LLCs are preferred over for-profit corporations as vehicles for social enterprise, especially for joint ventures between a tax-exempt nonprofit with a social change mission and a for-profit business.
LLCs are akin to partnerships because the members have broad discretion to allocate profit and loss and management powers among themselves (via an“operating agreement”). On the other hand, as with the shareholders of corporations, the members of an LLC can be divided into classes, each with its own economic rights, and members have limited personal liability (discussed below).
Two states, Tennessee and Kentucky, specifically authorize the formation of nonprofit limited liability companies (nonprofit LLCs). The statutes of numerous states, including California, have language that permits nonprofit LLCs to exist. Assuming state laws permit formation of nonprofit LLCs, the IRS will recognize such an LLC as exempt under Section 501(c)(3) if it elects to be treated as a separate legal entity for tax purposes and its operating agreement includes the language mandated by the organizational test (purposes, distribution of assets upon dissolution, etc.) and it meets numerous requirements largely designed to guard against inurement and private benefit. These conditions will be discussed in the Nonprofit Taxation section.
In order to form a limited liability company under the Washington Limited Liability Company Act, one or more persons must execute a certificate of formation. The certificate of formation must set forth: (i) the name of the limited liability company (which must contain the words “limited liability company,” “limited liability” and the abbreviation “Co.,” or the abbreviation “LLC”); (ii) the address of the registered office and the name and address of the registered agent for service of process; (iii) the address of the principal place of business of the limited liability company; (iv) if the limited liability company is to have a specific date of dissolution, the latest date on which the limited liability company is to dissolve; (v) if management is vested in a manager or managers, a statement to that effect; (vi) any other matters the members decide to include therein; and (vii) the name and address of each person executing the certificate of formation.
Unless a delayed date is specified (which may be no later than the ninetieth day after filing), the formation of the LLC is effective upon the filing of the certificate of formation. The certificate of formation must be filed together with a filing fee of $180 (plus a $20 fee for expedited service, if necessary).
LLC ownership interests are usually referred to as “units” or “membership interests” and the owners are “members” of the LLC. There is no limit on the number of members of an LLC, and the statute permits the formation of LLCs with only a single member.
The Washington statute does not specifically recognize nonprofit LLCs. However, the statute provides that “every limited liability company formed under this chapter may carry on any lawful business or activity unless a more limited purpose is set forth in the certificate of formation.” Thus, although they are not the most commonly used vehicle, Washington LLCs are not precluded from engaging in business with a social mission.
Please refer to the attached sample certificate of formation.
Management and Control
Typically, an LLC “operating agreement” among the members governs the management of an LLC. The operating agreement—which is like the articles of incorporation, bylaws and a shareholder agreement all in a single document— may contain provisions requiring adherence to a social purpose and such purpose and the values it embodies may be interwoven throughout the operating agreement. The operating agreement defines the rights, duties and liabilities of the members and managers. Members may manage the LLC themselves (in which case the LLC is “member-managed”) or delegate the management to a manager (in which case the LLC is “manager-managed”). If the LLC is manager-managed, the operating agreement usually describes the scope of the manager’s authority and certain significant decisions are reserved for the members.
Members are admitted as members of the LLC upon the later of (i) the formation of the LLC; or (ii) the time provided in the operating agreement, or when the person’s admission is reflected in the records of the LLC. After the LLC has been formed, the operating agreement usually determines how members are admitted. Members may assign their membership interests freely unless there are restrictions on assignment set forth in the operating agreement. However, the assignee has no right to participate in the management of the LLC unless the other members unanimously approve of such participation or the operating agreement allows for such participation.
Unless stated differently in the operating agreement, members have voting interests in proportion to their respective percentage interests in the LLC. The Washington statute provides that the following actions require the consent of the members holding more than fifty percent of the value of member contributions: (i) any amendment to the operating agreement; or (ii) authorization to act on behalf of the LLC that contravenes the operating agreement. The operating agreement may provide for classes or groups of members with distinct rights, powers and duties.
In the absence of an operating agreement, the allocation of profits and losses is governed by the Washington statute. The statute provides that profits and losses are allocated among the members in proportion to the agreed value of the contributions made or required to be made by each member. Similarly, distributions of cash or other assets are to be allocated among the members in proportion to the agreed value of the contributions made or required to be made by each member.
Please refer to the attached sample operating agreement.
Limited Liability of Members and Managers
Pursuant to RCW 25.15.125, members and managers of an LLC are not personally liable for the obligations of the LLC solely by virtue of their status as a member or manager. Members and managers are personally liable for their own misconduct, however.
The Washington LLC statute explicitly incorporates the “veil piercing” concept applicable to shareholders of a corporation. RCW 25.15.060 provides that members of Washington limited liability companies are personally liable for any act, debt, obligation or liability of the LLC to the extent that shareholders of a Washington corporation would be liable in analogous circumstances. Please refer to the LIability of Shareholders, directors and officers discussion in the For-profit Corporations section.
Merger, Dissolution and Term of Existence
Pursuant to RCW 25.15.395, a Washington limited liability companies may merge with one or more partnerships, limited partnerships, limited liability companies or corporations. The Washington limited liability company must approve a plan of merger setting forth (i) the name of the parties intending to merge; (ii) the terms and conditions of the merger; and (iii) the manner and basis of converting the equity interests in the merging party into equity interests of the surviving entity or into cash or other property. After the LLC adopts the plan of merger the surviving entity must file articles of merger with the Secretary of State, setting forth (i) the plan of merger; (ii) if the approval of any members, partners or shareholders of the merger parties was not required, a statement to that effect; or (iii) if the approval of any members, partners or shareholders of the merger parties was required, a statement that the merger was duly approved.
Pursuant to the RCW 25.15.270, a Washington limited liability company continues in existence until it is dissolved. The certificate of formation may specify a dissolution date. Otherwise, a Washington limited liability company may be dissolved upon the occurrence of the following: (i) it may be dissolved voluntarily by its members; (ii) it may be administratively dissolved by the Secretary of State for failure to comply with filing requirements; or (iii) it may be dissolved by judicial decree, in the event that it is not reasonably practicable to carry on the business in conformity with the limited liability company agreement or if other circumstances render dissolution equitable. A Washington limited liability company may also dissolve based on the occurrence of events specified in the limited liability company agreement, or ninety days following the dissociation of the last remaining member.
An LLC offers the same flexibility in raising capital as a for-profit corporation.
Recordkeeping and State Reports
Washington LLCs must maintain the following records at its principal place of business:
- a current and past list setting forth the full name and last known mailing address of each member and manager, if any;
- a copy of its certificate of formation and all amendments thereto;
- a copy of its current limited liability company agreement and all amendments thereto, and a copy of any prior agreements no longer in effect;
- unless contained in its certificate of formation or limited liability company agreement, a writen statement of: (a) the amount of cash and a description of the agreed value of the other property or services contributed by each member; (b) the times at which or events which will trigger additional contributions agreed to be made by each member; and (c) any right of any member to receive distributions which include a return of all or any part of the member’s contribution;
- a copy of the limited liability company’s federal, state and local tax returns and reports, if any, for the three most recent years; and
- a copy of any financial statements of the limited liability company for the three most recent years.
Unless it elects to be treated for federal purposes as a corporation, an LLC is generally not subject to separate entity-level taxation of its income under federal tax laws, although it is required to file an informational return. Unless a member is exempt from income taxation, usually its distributive share of membership income and loss is treated as income or loss to the member and reported on his/her/its return, regardless of whether the member actually receives the income. LLCs that have one owner are generally disregarded as entities separate from their owners.
Unlike many states, Washington does not have a state income tax. Instead, businesses in Washington are subject to the state and local business and occupation tax (the “B&O tax”). Washington’s B&O tax is calculated on gross income; there are no deductions for labor, material, taxes or other costs of doing business. Generally speaking, almost all companies that conduct business in Washington are subject to the B&O tax, including corporations, limited liability companies, partnerships and nonprofit organizations. However, certain exemptions, deductions and credits may be available depending on the nature of the corporation’s activities in Washington. Please refer to Recordkeeping, State Reports and State Taxes discussion in the Nonprofit Corporations section for an analysis of applicable state and local taxes.
- Humphreys, Thomas, Limited Liability Companies and Limited Liability Partnerships (Incisive Media, 2009)
- See the Secretary of State’s website at: http://www.secstate.wa.gov/corps/LimitedLiabilityCompaniesLLC.aspx